10/07/2009 @ 6:00AM

The Reason Stanford Is Selling Private Equity

Stanford University’s current effort to sell up to $1 billion of private equity and other hard-to-sell assets is being driven by large and unfunded commitments of future investments that its endowment made to private equity shops and other illiquid investment vehicles prior to the credit crisis.

“We are confident in our ability to manage through, but we would like to be a little more liquid,” John Powers, chief executive of the Stanford Management Co., which manages the endowment, said in an interview. “Taking some current [net asset value] off the table as well as alleviating some of the unfunded is a good way to do that.”

The university’s $12.6 billion endowment, which lost a quarter of its value amid the credit crisis, has committed to making $6.1 billion of capital calls to investment partnerships in the coming years, according to Moody’s Investors Service, a rating agency. Meeting those capital calls–which are unlikely to come all at once, but might come quicker than any sizable income generated from its current private equity portfolio–could drain cash needed to fund operations at the Palo Alto, Calif. university.

Stanford is attempting to dispose of as much as $1 billion of combined funded and unfunded commitments to illiquid investment assets, including private equity funds, real estate partnerships and timberland investments. That would significantly reduce the Standard Management Co.’s exposure to such illiquid assets, which currently make up one-third of its investment assets.

The endowment’s managers hope to sell only part of its stakes in private equity partnerships–interests of about 10% to 20%–along with the commitments that stick with them, as opposed to its entire ownership in specific partnerships.

In an interview, SMC’s Powers emphasized that the university is currently in a strong financial position, pointing to the $1 billion of taxable bonds Stanford sold earlier this year that carried a blended rate of 4.3%. The university has not drawn on that $1 billion of cash it raised, which is currently sitting in a money-market account. “We are investigating this, we are not being forced to do this,” Powers said of the effort to dispose of slices of investment partnerships.

Powers, who was appointed head of Stanford’s endowment in 2006, said that he started to think about selling some of the endowment’s private equity assets a year ago, but did not pursue such an effort because he had enough cash on hand and the secondary market for private equity assets was weak. Indeed, Cogent Partners, the Dallas advisory firm that Stanford has hired, reports that the $2.5 billion of private equity fund sales it helped arrange in the first half of 2009 attracted bids of 50% of their net asset value as of the end of 2008.

But there have been recent indications that the secondary market for private equity assets is rebounding strongly, according to people familiar with the market. “There is at least enough signs of strength in the market,” says Powers.

Still, the biggest university endowments in the country are struggling to deal with their large exposure to private equity and illiquid asset classes. The endowments of Harvard University, Yale University and Stanford rushed into these riskier investments to chase out-sized returns. The strategy worked very well for years, but produced some terrible results amid this credit crisis.

As Forbes reported early this year, large exposure to private equity and other illiquid investments, coupled with the use of leverage-enhancing derivatives, caused a liquidity crisis a year ago at the Harvard Management Co. Harvard recently reported that in fiscal 2009, its private equity portfolio fell by 31.65% and its real estate partnerships tumbled by 50%.

Harvard endowment chief Jane Mendillo recently admitted in a report that “with perfect hindsight, we and most other investors would have started this year in a more liquid position and with less exposure to some of the alternative asset categories that were hardest hit.”

That seems to be the lesson many endowment managers, including Stanford’s Powers, seem to be drawing. “Had we anticipated the steepness of the drop in the liquid markets, we would have wanted to have less in the way of illiquid exposure,” Powers said.